Analysis of the Accounting Cycle
The accounting cycle encompasses the period of time from the beginning of the accounting period before recording any transactions until the end of the accounting period when every transaction has been recorded. The end of one accounting cycle represents the beginning of the next.
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Record Transactions
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The accounting staff records financial transactions throughout the month as they occur. These transactions include customer sales, invoice payments and payment of wages. At the time the transaction takes place, a source document is transferred to the accounting staff. The accountant uses the source document to determine the type of transaction and which accounts to record the transaction against. The accountant records these entries in the journal and then posts the amounts to the general ledger.
Make Adjusting Entries
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Accountants need to recognize transactions at the end of the month when no source documents exist. A portion of prepaid insurance expires every month as the company receives the benefit of the insurance coverage. No document circulates at the end of the month to recognize this expiration. Another example of a transaction lacking source documents is revenue earned by providing services to customers and not billing by the end of the month. These revenues need to be recognized for the period even though no document exists. The journal entries to record the expiration of prepaid insurance or the revenue earned and not billed are called adjusting entries.
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Create Financial Statements
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After the adjusting entries are completed, the accountant creates the financial statements. If the financial statements are created prior to recording the adjusting entries, the statements will be incomplete. The accountant creates the balance sheet, income statement, statement of owner's equity and the statement of cash flows for distribution to the company's investors and creditors.
Record Closing Entries
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After the financial statements are finalized, the accountant records the closing entries. Every company's financial records contain temporary accounts, or accounts that only contain a balance during the period. These accounts begin the period with a zero balance and return to a zero balance through the closing entries. The temporary accounts include revenues, expenses, owner's drawing and income summary.
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